This is a question that I am struggeling with as I know I'm about 30 years till retirement, and am moving from an active strategy (how I got introduced in my early 20s to the investing world) to a long term passive strategy.

Thoughts? This should be such a simple question, but I'm finding this to be the most difficult question to answer (from a Long Term Return vs. SD reduction standpoint)

For what it is worth, I am 28 years old and I am sticking with 110 minus my age in stocks. Here is how I'm broken down:

Target of 82% stocks 18% fixed income.

Equity portion (82% of portfolio)
60% in U.S. total market index fund
30% in Total Int'l market index fund
10% in REIT Index

Fixed Income (18% of portfolio)
100% U.S. Bond Index fund

I chose to include the REIT fund to lower SD, but don't really expect it to increase returns (if it does, great). I've never bothered to see how a portfolio did like this in the past, but tried Simba's spreadsheet and here is what I got:

1972-2006
11.70% CAGR
13.59% SD

Regardless of what this (or any) allocation did in the past, the future is unknown and uncertain.

Best,
Peter

P.S. Full disclosure, this allocation will be drastically changing for me in the coming months as I utilize Vanguard's new Total World Stock Index Fund.

To the extent that a fool knows his foolishness, |
He may be deemed wise |
A fool who considers himself wise |
Is indeed a fool. |
|
Buddha

Let's say you log in to your brokerage account and see $100,000 in there. Then you log in a few months later and there's only $65,000 in there. How would you feel about that? Could you stay the course and leave the money invested?

Your bond allocation should reflect your need and your ability to take risk. You are young which should increase your ability to take risk, since your time horizon is long. However if you make tons of money then you might not need to take a lot of risk to meet your goals.

Personally I am slightly more conservative than 110 minus age in stocks - I go for the old "age in bonds" method. This reflects my personal need and ability to take risk.

This is a question that I am struggeling with as I know I'm about 30 years till retirement, and am moving from an active strategy (how I got introduced in my early 20s to the investing world) to a long term passive strategy.

Thoughts? This should be such a simple question, but I'm finding this to be the most difficult question to answer (from a Long Term Return vs. SD reduction standpoint)

Thanks for the help.

Hi C:

Our stock/bond allocation is our most important portfolio decision and one of the most difficult (it's not just "age"). Only you can make that decision and it depends on:

I tend to recommend at least 10%, so at least there's the psychological benefit in a bear market of having SOME part of your portfolio that's still making money. Although with 10%, the benefit is mainly psychological, not financial.

As Taylor mentioned, it is YOUR decision, but if you're just looking for examples....

My wife and I are both 28 years old. I'm in the process of fine-tuning all of my retirement accounts to work in unison, but my goal is 85/15 stock/bonds, but I would probably be willing to go up to 90/10. As you said, you have 30+ years to go.

We are all in index funds, except my wife has some money in Vanguard Explorer Admiral through her 401k.

caklim00 wrote:Thoughts? This should be such a simple question, but I'm finding this to be the most difficult question to answer (from a Long Term Return vs. SD reduction standpoint)

Ideally you would like to spread the investment risk evenly across time. That isn't possible, but the closest thing is to take as much risk as possible in the early years, and reduce risk later. The "life cycle" funds try to do this by gradually adding bonds. However, this strategy assumes that you will keep saving no matter what the market does (when in reality you might lose your job in a recession, at the same time the market tanks).

caklim00 wrote:Thoughts? This should be such a simple question, but I'm finding this to be the most difficult question to answer (from a Long Term Return vs. SD reduction standpoint)

Ideally you would like to spread the investment risk evenly across time. That isn't possible, but the closest thing is to take as much risk as possible in the early years, and reduce risk later. The "life cycle" funds try to do this by gradually adding bonds. However, this strategy assumes that you will keep saving no matter what the market does (when in reality you might lose your job in a recession, at the same time the market tanks).

Most lifecycle funds seem to have a 90/10 allocation for long term investors. Maybe this is the best route to go...

This decision can't based on someone else's opinion, or a formula/guideline - it should be based on your need and ability (I left out willingness on purpose) to take risk. Believe me, the market will test your ability.

Be careful, at 28 (you were 20 in 2000), you haven't been tested to handle a 45% drop in your nest egg.

Regards,
Landy

Last edited by YDNAL on Tue Jul 01, 2008 2:05 pm, edited 1 time in total.

I'm with Larry, but his 100/0 recommendation was undoubtedly for the long-term portion of your portfolio only.
For you overall portfolio, check out his Liquidity Test section on page 173 of his book The Only Guide to a Winning Investment Strategy You'll Ever Need where he suggests that any money needed in the next 5 years should be out of stocks. When you get older, you could make it any money you need in the next 10 years should be out of stocks.

I'm with Larry, but his 100/0 recommendation was undoubtedly for the long-term portion of your portfolio only.
For you overall portfolio, check out his Liquidity Test section on page 173 of his book The Only Guide to a Winning Investment Strategy You'll Ever Need where he suggests that any money needed in the next 5 years should be out of stocks. When you get older, you could make it any money you need in the next 10 years should be out of stocks.

Bob

I have no (expected) need for money within the next 10 years. I have (I think) a stable job and my wife will be begining a new position from after college in August. I already own a house (20% down), and don't plan on moving in the next 5 years. So, my liquidity needs will be very low (unless the unexpected happens --> and this shouldn't with insurance and DB protection)...

Yes, Lary's book that you referenced is where I pulled the original 100/0 Asset Allocation from.

From a liquidity standpoint I probably should be closer to 100/0, but if you believe Bernstein that the future returns between stocks and bonds will be similar then I probably should be closer to 80/20.

I tend to recommend at least 10%, so at least there's the psychological benefit in a bear market of having SOME part of your portfolio that's still making money. Although with 10%, the benefit is mainly psychological, not financial.

I'm not so sure about that. Plenty of backtested data shows a tangible risk reduction without giving up much (if any) return. For that reason, I have a 80/20 allocation.

My portfolio, which I arrived at after much hand-wringing:
80/20 equities/bonds
66/33 US / foreign split (will slowly increase to 60/40 over time)

Breaking it down - there is a good mix of low-correlated assets here. Both US and Int. are tilted to small and value, I hold a fairly standard REIT allocation, and I stick only to the safest of bonds as a portfolio anchor. I think this was the simplest way to acheive it as I hold relatively few funds.

I have a very stable job with decent income. Therefore, given that tilting to small and value has extra risk I felt it was appropriate for me to seek those premia. In spite of the stable job, I still hold 20% bonds. I'm not convinced that stocks will hold a large advantage over bonds in the returns department going forward. I've seen the data showing 80/20 compared to 100% equities and the 80/20 is far more compelling to me.

I am fortunate to have no-cost trading access to ETFs in my brokerage and Roth accounts - otherwise I would surely have a more typical asset allocation without commodies, without int. small value, etc.

I am 36 and until last fall, I was almost 100% in Equities (and most of it in single stocks). The market made me nervous and I changed fairly quickly

a) to almost a 50/50 allocation of stocks and bonds
b) from single stocks to index funds / ETFs

...and both of which made me sleep much better during the last 6 months.

I guess the point I am trying to make is that your capability to accept risk can change fairly quickly, at least it has for me. Also, in this market I don't see you giving up a lot of extra returns by moving a bit more money into bonds, however it might make you feel/sleep much better by reducing volatility. In your situation I would probably go with 30/70.

Larry Swedroe made a really good case for TIPS dominating the fixed income portion of a portfolio - search for that here.

The reason I split 50:50 TIPS : IT are the following:

1) TIPS are a separate asset class from nominal bonds and have different expected correlations to equities.
2) I use IT instead of ST treasuries to gain a bit more return. Having stable job / commodity exposure allows that.

Nothing wrong with ST:IT mix as well, or even bond index:TIPS. I suspect it doesn't matter all that much.

waitforit wrote:Larry Swedroe made a really good case for TIPS dominating the fixed income portion of a portfolio - search for that here.

The reason I split 50:50 TIPS : IT are the following:

1) TIPS are a separate asset class from nominal bonds and have different expected correlations to equities.
2) I use IT instead of ST treasuries to gain a bit more return. Having stable job / commodity exposure allows that.

Nothing wrong with ST:IT mix as well, or even bond index:TIPS. I suspect it doesn't matter all that much.

Interesting, I'll have to take a look at Larry's book tonight. In the end I'm just hoping to smooth returns a bit without sacrificing too much long term returns with my bond allocation.

waitforit wrote:Larry Swedroe made a really good case for TIPS dominating the fixed income portion of a portfolio - search for that here.

The reason I split 50:50 TIPS : IT are the following:

1) TIPS are a separate asset class from nominal bonds and have different expected correlations to equities.
2) I use IT instead of ST treasuries to gain a bit more return. Having stable job / commodity exposure allows that.

Nothing wrong with ST:IT mix as well, or even bond index:TIPS. I suspect it doesn't matter all that much.

Interesting, I'll have to take a look at Larry's book tonight. In the end I'm just hoping to smooth returns a bit without sacrificing too much long term returns with my bond allocation.

For what it's worth, I'm 35 and have a high income with a stable job..I go all equities and REITs now, until all my debt (student loans and mortgage) are paid off or substantially paid off...i view the debt payoff as the fixed income portion of my portfolio...good luck

waitforit wrote:Larry Swedroe made a really good case for TIPS dominating the fixed income portion of a portfolio - search for that here.

The reason I split 50:50 TIPS : IT are the following:

1) TIPS are a separate asset class from nominal bonds and have different expected correlations to equities.
2) I use IT instead of ST treasuries to gain a bit more return. Having stable job / commodity exposure allows that.

Nothing wrong with ST:IT mix as well, or even bond index:TIPS. I suspect it doesn't matter all that much.

Good point on the 95-99 test. I guess it really depends where the market has been at in the few years leading up to retirement, doesn't it?

Big picture to me though is what CAGR can I expect during my years of investing. I'd rather have a CAGR of 14 with deviation of 30 than 10 with deviation of 8, but I cannot know that in advance - so the prudent thing is to include some bonds and shoot for a CAGR of 10 with deviation of 12.

CAGR = Compound Average Growth Rate

How do people on here get exposure to TIPS?

TIPS fund for me. VIPSX is a good one, there also some TIPS etfs out there.

I've been reading Jack Brennan's "Straight Talk on Investing". His statement on page 60 made me much more comfortable with my 70/30 split (it seems that I'm just not as aggressive as other 28 year old compatriots).

The key thing to remember about balance (between stocks and bonds) is that at any point in time it will look like a dumb strategy.... With a balanced portfolio, it's true that you'll never be earning as much as you'd get if you managed to put all your money in the asset class that was destined to be the year's top performer.

I've been reading a bit, and IMHO I get the impression that the current climate is much more aggressive on the stock/bonds balance than in older pre-internet bubble books. I'm not totally sure why and its just my anecdotal experience but I have noticed that currently, (and definitely on this board), people are weighing very heavily on the stocks (and certainly international stocks).

Here's another interesting chart from Brennan's book (Page 71)
Mix -----> Number of years out of 76 with a loss (Betw 1926-2001)
50/50 17 years (22%)
60/40 19 years (25%) Exactly one out of four
80/20 21 years (27%)
100/0 22 years (29%) Almost three years out of ten